No Shortcut Through Poland's Maze

By
Maurice Ernst /
November 8, 1989

IN a series of articles and influential visits to Poland, Prof. Jeffrey Sachs of Harvard University has advised the Polish government to move from a centrally planned to a market economy in one fell swoop. This prescription of adjustment through ``shock treatment'' has appeal. It promises quick results during what may be a brief period of national consensus under the Solidarity-led government of Tadeusz Mazowiecki. It has been applied successfully to other countries (e.g., Bolivia in 1985), whereas the gradualist approach to economic reform and adjustment has generally not worked because it gave time for political resistance to build.

But Poland is different: The shock approach would be disastrous and a different approach is needed.

The big difference between Poland and the countries which successfully implemented shock-treatment adjustment is that Poland is still predominantly a Soviet-type planned economy run by a massive bureaucracy in which markets for goods and services are few and generally small. In these other countries markets existed in the larger part of the economy.

In Poland, limited free markets exist only for foods, foreign exchange, and the products of the small but rapidly growing private industrial and service sector. There is a fundamental difference between improving the operation of existing institutions and creating institutions from scratch. Turkish manufacturers and Bolivian peasants could respond quickly to price incentives.

But the Polish industrial producer typically buys materials and components from, and sells to, a monopolistic state agency. Moreover, much of production is dominated by one or two large firms. These institutional constraints make it difficult, perhaps even impossible, for producers to respond to incentives.

What would happen if Poland administered the shock treatment of letting the prices of goods, services, foreign currency (the exchange rate), and financial capital (interest rates) bring supply and demand into balance? Many firms would receive massive windfall profits while many others would suffer massive losses. And since supply adjustments would be slow or impossible, there would be little increase in production and employment to offset the production declines and layoffs.

It is not difficult to imagine unemployment reaching 20-25 percent of the labor force. And what would then happen to Poland's newborn democracy? Most likely there would be a ``populist'' reaction in which the unemployed, the many others who would fear unemployment, and the Communist Party and government bureaucrats would make common cause, throw out the Solidarity government, and impose new controls both on the economy and on political and individual freedom.

At best, Solidarity would splinter, leading to indecisive, unstable governments. At worst, a ``law-and-order'' government would eventually take over to reestablish stability.

If the shock approach will not work, what should Poland do? I believe that a multi-year (probably about four-year) program of reform and restructuring, during which market institutions and a job market for those who are laid off are created, is needed.

The program should be phased, however, to fit political realities as well as economic needs.

Having been pushed into the political leadership by a massive anticommunist popular consensus, Solidarity must now lead the nation through an extremely difficult and painful transition with a political base that spans the entire spectrum from free-market Reagan to left-wing British labor. And it must persuade a skeptical, if hopeful, public, which has had to cope with 300 percent inflation and has seen its living standards decline despite repeated government promises of improvements, to tighten its belt once again.

If the economic situation does not improve soon, Solidarity will probably begin to break up, and, although this does not mean the communists would return, a unique opportunity to put the country on the right track will have been lost. An intense debate has been under way in Poland on how to deal with this dilemma - undertaking disruptive reforms and also raising living standards. While there are many possibilities, the following scenario may suggest some feasible lines of action.

THE reform program is in four phases:

In Phase I, which covers the next three or four months, the government breaks the inflationary spiral by increasing the supplies of foods and foreign exchange available to the population. The necessary resources come mainly from cuts in government investment and from Western aid. These actions, plus the fact that the freeing of agricultural prices and the resulting dramatic rise in the cost of living has already occurred, could bring down inflation from an annual rate of several hundred percent to maybe 25 percent.

The government then proceeds to Phase II, that of relatively easy restructuring, during which most industries that produce goods and services for the consumer market are decontrolled. This includes the bulk of light industry, food processing, and a wide range of services. Except for foods, subsidies on which may have been removed recently, these industries have been more taxed than subsidized and have many firms that could form the basis for competitive markets. Privatization of some firms, joint ventures with foreign firms, and the breaking up of state trading monopolies would be essential. In addition, consumer industries would have to receive an increased priority for supplies of fuels, power, and foreign exchange. Under these conditions, consumer goods production could probably begin to increase within a few months both for the domestic market and, given a favorable exchange rate, for export.

Even moderate success in Phases I and II would give the Polish people some reason for optimism about the future. In turn, that might be sufficient to elect a majority Solidarity government in the next free legislative elections. Although these are not required to take place for another four years, Solidarity is so disparate that it almost certainly cannot hold together that long, even if economic conditions improve. But it almost certainly can negotiate an earlier date for the elections, such as spring or summer of 1991, or about two years after the last elections. Even if some groups were to split off from Solidarity, so long as the mainstream elements - the skilled and semi-skilled workers who favor some form of social democracy and the liberal, free-market oriented businessmen and intellectuals - stick together, they could form an effective government.

The new government then launches Phase III, the most difficult restructuring phase, in which heavy industry, the hard core of the state sector, is slowly broken up and recast, with ownership passing to private individuals or private or public corporations. Some monopoly enterprises remain and have to be regulated. This restructuring also involves deep cuts in the bureaucracy and would result in large layoffs, but there would be a large enough cushion in the expanding private sector and the reformed state-owned consumer industries to absorb many workers. Unemployment would be substantial, probably over 10 percent of the labor force, but manageable.

Phase IV, the final phase, could be introduced in late 1993 as a classic financial stabilization program involving a unified exchange rate, convertibility of the zloty, completion of an operating capital market, and fundamental tax reform, perhaps along the lines of the European Community. This would be accompanied by a large package of financial support in the form of a massive reduction in debt-service obligations by the Paris Club and the private bank creditors, coupled with new credits from the International Monetary Fund and the World Bank.

The stabilization cuts inflation to single digit levels and sets the scene for rapid, export-led economic growth. Although Polish governments will fall and new coalitions will be formed, the transition to a largely market economy will have been accomplished.

I believe that this is a plausible scenario to bring Poland through the difficult and risky transition from a Soviet-type communist system to a Western European-type social democracy. Moscow would not be pleased at such a durable political change in Poland, but would find virtue in the improvement of the Polish economy and in the country's political stability.

The Soviets would probably not interfere if Poland maintained its military links with the Warsaw Pact and took care not to tread on important Soviet interests. Although the West cannot determine Poland's fate, it can, by opening up its markets and through well-timed economic aid and sensible advice, make the difference between the success and the failure of a transformation that has no counterpart in history, but enormous implications for the future.